HB37)7 

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HB 3717 

j_g0Q REPRINT FROM 

■•^"^ THE JOURNAL OF COMMERCE 

Copy 1 

of April 18th, 1908 



HOW TO 



BELIEVE THE DEPBESSi 



A SUGGESTION 

FOR RAILROAD MEN AND BANKERS 



BY 



N. JOHANNSEN. 



^-^^'^^Sr 



NEW YORK, April, 1908. 



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HOW TO 

RELIEVE THE DEPRESSION. 



ACCORDING to modern observations the degree of a country's pros- 
perity and business activity bears a close relation to the extent 
of new constructions and improvements that happen to be under way. 
Of such there has been no lack in recent years; the steady increase of 
our country's wealth, of three or four billions per annum, having con- 
sisted chiefly of new constructions. The cash capital needed for these 
was supplied, to a small extent, by credit institutions^— about 
$600,000,000 per annum; the bulk of it coming from the people's 
savings and surplus earnings. 

After the panic set in, reducing earnings all around, the people's 
saving power became smaller and may not exceed two billions per 
annum at present. But the extent of new constructions has dwindled 
down much more and may, at present, not absorb more than half of 
the people's savings. What becomes of the balance? Naturally, 
these savings will, first of all, appear in the commercial banks, forming 
the idle cash funds of the money market. But only a small share 
of them will stay there; the bulk will flow out again, and will finally 
return into the channels of production and trade, without leading to any 
visible results. The modus operandi of this peculiar process has never 
been explained by our economists. It has been argued that the funds 
so absorbed at times of depression were needed for the money market's 
"other requirements," resulting from borrowing, straining of credit, etc., 
and that, on this account, an extended depression was really a matter 
of necessity, to readjust those strains. I have made this subject the 
study of my life and have found that those "other requirements" do 
not exist and that at times of depression the people's savings meet 



their investment largely in a manner quite injurious to the country's 
welfare. The supposed inherent necessity for an extended depression 
cannot be substantiated, and the sooner we discard this supposition the 
better. And again, the sooner we can divert the investment of savings 
funds from that injurious course (the nature of which I shall explain 
in a subsequent publication) and direct them to their legitimate sphere, 
enterprise and new constructions — where they would give employment 
to some of the working forces now idle — the better for all concerned. 

What prevents the idle funds of the money market from going into 
enterprise and new constructions, the same as before? They are pre- 
vented by the lack of demand. 

Before the panic the demand for commodities seemed to be insatia- 
ble, and the means of production (factories, etc.) had to be con- 
stantly increased to enable production to keep pace with the ever-in- 
creasing demand. After the panic set in this demand dwindled down 
considerably, and the productive capital then in existence proved to be 
more than sufficient to provide for the reduced demand, so the incen- 
tive for new constructions and for the extension of productive capital had 
disappeared — and therewith the opportunity for investing cash funds 
and savings funds in their legitimate sphere. Instead of the dearth of 
cash capital so noticeable before the panic we now see a plentiful 
supply of funds in the money market, with apparently no use for them. 

To find useful employment for these funds where there is no need 
for them in the lines of industry, that may seem a hopeless task. Yet 
there is one line which possibly may allow us to put our lever in, and 
that is — the railroad industry. This is situated quite differently from 
the other great industries. It has not, like these, doubled or trebled in 
extent during the past ten years, but has expanded only at a moderate 
percentage, so far as capital and mileage are concerned ; while, on the 
other hand, traffic and earnings have increased enormously. In con- 
sequence, many of the railroads are sorely pressed for extending their 
facilities, even though this may not seem true just at present. They 
need cash capital, not only to pay debts recently incurred, but to pro- 
vide for future requirements. According to the opinion of Mr. James 
J. Hill, these requirements will call for the stupendous sum of a billion 
dollars annually for a number of years to come. 



Thus, we find a strange paradox in the money market — -on the one 
hand a superfluity of cash funds looking for employment; on the other 
a number of railroads looking for cash funds which they cannot get. 
Why can't they? What stands in the way against bond issues at a 
reasonable rate of interest, say 4 or 4^4 per cent? 

I attribute the cause to three distinct reasons: First, distrust, 
arising partly from foolish State legislation, attempting to harass the 
railroads, partly from sharp practices on the part of railway magnates, 
such as led to the wrecking of the bonds of Rock Island and of 
Metropolitan Street Railway; second, the low market prices (which 
seem to justify that distrust) of the bonds and stocks already extant; 
why should investors subscribe to new bond issues at par if they can 
buy similar bonds below par in the open market? third, investors have 
the idea that after the return of prosperity, when the interest rate will 
rule higher, they can invest their funds to better advantage than now. 

As to this last point, people are mistaken, so far as concerns the 
purchase of bonds and securities. Let us take an example, say. Union 
Pacific 4 per cent, bonds; at the boom time they were selling around 
1 06, now at 1 00 — so the investor can buy them to better advantage 
now than before. By rights those bonds, of almost absolute security 
as they are, ought to sell higher than at the time of the boom, now 
that the rate of interest rules low. Their reduced price is really para- 
doxical. It is due to the general feeling of uncertainty, which cannot 
last much longer, and as soon as it disappears, the security prices, as 
everybody knows, will go up. 

As to point two, this embodies another paradox, namely, that 
most investors will buy securities when they are high rather than when 
they are low. At present they are altogether too low to look inviting 
to the average investor. It may seem a bold assertion that if our big 
financiers would simply mark up the prices of securities ; not only mark 
them up, but keep them up (which is not a difficult matter for them 
to do), the securities would be bought much more eagerly than now; 
and not only securities already extant, but new issues as well. This 
assertion is amply corroborated by past experience. 

As to point one, we have to admit that the general distrust and 
the feeling of uncertainty have much to do with the present unfortunate 



situation. Owing to this feeling the railroads cannot borrow and the 
fact that they cannot borrow confirms that maleficent sentiment. Here 
it may be advisable to resort to manipulation in order to overcome 
that sentiment, at least so far as railroads are concerned. I suggest 
that a syndicate of prominent bankers be formed, guaranteeing the in- 
terest on new bond issues of railroads of good standing; the syndicate 
to have full power to guard the interests of the bondholders, say, by 
vetoing any measures of the managers which may endanger the safety 
of the bonds and eventually by foreclosure. 

The syndicate may charge the railroads a fee of 5 per cent, of 
the amount of interest covered by the guarantee. This fee would 
constitute no burden for the railroads — just the reverse. Let us take 
an example. Last year the Union Pacific Railroad issued 4 per cent, 
convertible bonds at 90. Under the syndicate's guarantee these new 
bonds would be fully as safe and valuable as the railroad's first mort- 
gage bonds, which at that time stood at 105. With the help of the 
syndicate's guarantee, therefore, the new bonds could have been issued 
at par and the railroad would have saved much more than the 5 per 
cent. fee. 

The risk on the part of the syndicate would be only nominal, 
and the fee almost clear income. Such a syndicate arrangement 
would prove profitable all around — to its members, to the railroads, 
and (a hundred times more important than either) to the public in 
restoring confidence. 

The syndicate may go even further in helping the railroads — by 
first getting their numerous "short term" notes out of the market. So 
long as these 5 and 6 per cent, notes can be bought below par, in- 
vestors may not feel like buying new issues of 4 per cent, long term 
bonds at par. The syndicate may buy them up and procure the nec- 
essary funds in the same manner as the stock brokers do who hold 
securities for their customers on margin, borrowing the funds from the 
banks "on call" at less than 2 per cent, and charging their customers 
4 per cent. For every million dollars of notes so bought, the syndicate 
would put a million dollars of idle cash funds into the hands of the 
sellers. The latter naturally will look for some other kind of invest- 
ment for their funds, and may buy the long term bonds offered by 
the syndicate. 

6 



In conclusion, I will say, it would be folly under ordinary cir- 
cumstances to try to relieve a depression by mere financial manipulation. 
With us, however, the situation is unusual- — a great industry in need 
of funds and the money market weighted down with a plethora of 
funds — a situation which may not occur again in a lifetime. Here 
manipulation seems justified. Let us help the railroads, and they will 
help us. If we enable them to raise the funds they need for building 
and improving they will give employment and income to some of the 
working forces now idle; the latter, when expending their income in 
buying what they need, will call a further set of working forces into 
activity, and the well known interplay of action and reaction, thus 
started, may do its part toward relieving the depression, to some 
extent, at least. 



LIBRARY OF CONGRESS 





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